At the time the Contract was originally signed, the Authority will have undertaken a rigorous assessment of a number of issues affected by the level of indebtedness of the Contractor, including:
- the extent and profile of incentives for shareholders over the life of the Contract;
- the financial flexibility which the Contractor will have to manage routine risks; and
- the financial robustness of the Contactor to withstand the adverse impact of major project risks.
Each of these issues will have been considered from both short and long-term perspectives; longer-term perspectives are particularly important in relation to the proposed amortisation profile of the Senior Debt and the proposed pattern of distributions to shareholders. All these factors will need careful consideration given that Refinancing proposals may involve both increased borrowings and shareholders realising substantial gains from the Project at the time of the Refinancing.
Whilst there are many areas where the interests of Senior Lenders and an Authority may be the same under a Contract, this is not always so, and an Authority cannot rely on Senior Lenders' judgement about the acceptable level of indebtedness of the Contractor. An Authority and its advisers must form their own view on an appropriate level of indebtedness. The situation is exactly the same in the case of Refinancing. An Authority receiving a Refinancing proposal must repeat this rigorous evaluation of the maximum acceptable level of Senior Debt.
Since a Refinancing is normally undertaken in circumstances where a project has successfully passed a major risk-reduction milestone (such as completion of construction) it will normally be the case that the maximum level of Senior Debt which is acceptable for a Contractor under a Refinancing will be greater than at the time the Contract was originally signed. Indeed, Contractors' Refinancing proposals often assume a significant increase in their level of borrowings. In evaluating such a proposed increase, it is important for the Authority to remember that the level of Senior Debt it considered acceptable at Financial Close was somewhat below the original funding requirement3 of the Project, whereas a Refinancing proposal may involve a level of Senior Debt in excess of this original funding requirement. As SoPC cautions (SoPC §35.3.1.7), a move to such an increased level of indebtedness should only be accepted by an Authority after rigorous evaluation.4
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3 The original funding requirement against which the gearing ratio of senior to junior capital was quoted at the time of financial close (e.g. 90/10), i.e. all construction period hard costs as well as soft costs such as rolled-up interest
4 An important exception exists to this general note of caution about increased Contractor indebtedness and where the Authority's interests will generally be well served by the Senior Lenders insisting on their own view of acceptable increases in levels of Senior Debt. This is when the Project is in financial distress and Senior Lenders have decided to make further advances under the Additional Permitted Borrowings provisions of SoPC (cf. SoPC Annex 4: Guidance Note on "Permitted Borrowing") to help restore the Project to financial health. In such cases Authority consent is not required. However, in considering the position on future termination liabilities at the time of a Refinancing (cf. §1.3), an Authority should have in mind the possibility that these may be increased through Additional Permitted Borrowing.